Your secured savings landscape is bound to change, and how

Interest rates on Public Provident Fund (PPF) to be linked to the market yields on government securities of comparable maturity,
Annual reset of interest rates of NSC, PPF, etc and Discontinuation of Kisan Vikas Patra instruments.   

These and many other recommendations shall become reality if the government accepts the last week’s report of the committee headed by Shyamala Gopinath, deputy governor of the Reserve Bank of India (RBI). The committee was formed to recommend reforms required in overall administration of National Small Savings Fund (NSSF).

Table 1 shows small savings schemes covered under NSSF and on which the recommendations are made in the report.
The report acknowledges the importance of small saving schemes:

“Small saving schemes have been always an important source of household savings in India. Although these instruments are technically not government securities and do not have any explicit government guarantee, their legacy has given them characteristic of being equivalent to that of a sovereign liability. These schemes have been extremely popular amongst a large number of small investors in India who seek to invest in a secure instrument. At the same time, these instruments have been treated as a means of providing social benefit to the small savers.”

Hence the benefits these schemes provide to various sections of the population, especially small savers, are beyond doubt.  In this article, Bachhat lists down key recommendations made by the committee which directly impacts the investors.
Changes in interest rates

One of the key recommendations of the committee relates to the interest rates. The committee recommends that, other than for savings deposit, interest rates for all other instruments should be benchmarked against secondary market yields on central government securities of comparable maturities and should be reset yearly. It means that as the interest rates of government securities rise, the interest on these securities shall also increase and vice versa.

The committee has, depending on the instrument, its liquidity and its tenure, also recommended a spread of minimum 25 basis points (bps) vis-a-vis government securities of comparable maturities. 100 bps is equal to 1 percentage point. The spread is larger for NSC (50 bps) and Senior Citizen Savings Scheme (100 bps).  For eg: If a comparable security for PPF is trading at 8%, then the interest rate on PPF for the reference period shall be 8.25%.

Further, to avoid year-on-year volatility, a cap of 100 bps has been recommended so that the rates are neither raised nor reduced by more than 1% from one year to the next, even if the benchmark rates fluctuate by higher margins. These rates shall be fixed in advance and shall be known before the start of the
financial year.

The committee recommends that interest rates on postal savings deposits should be in line with rates offered on bank’s savings account and be increased to 4% from current 3.5%. Further, the interest should be calculated on a daily basis on such deposits.

Other recommendations
1. Option of premature withdrawal of time and recurring deposits with provision to pay lower interest rate in such cases.
2. Abolition of 5% maturity bonus on Monthly Income Scheme (MIS) and reduction in tenure from 6 years to 5 years.
3. Increase in annual investment limit for PPF to ¤1 lakh. To discourage premature withdrawal, interest rates on advances against PPF deposits should be 2% higher than the prevailing PPF interest rate (as against 1% at present).
4. NSC to be available with maturities of 5 years and 10 years (as against 6 years NSC at present) with interest rates linked to comparable G-sec rates. No income tax exemption under Section 80C on accrued interest from NSC.
5. The committee has also recommended reduction in commission paid to agents for the products sold. Table 2 gives the existing and the proposed commission structure. This and similar changes which happened in mutual fund industry earlier, will lead to emergence of fee based financial service industry wherein agents will start charging customers directly for the services provided by them.

Effect on the current interest rates
Assuming that the government accepts these proposals and implements the same with effect from July 1, 2011, the revised administered interest rates based on above recommendations are shown in Table 3.

Bachhat’s take
Above recommendations, if implemented, will have long term impact on the way individuals save. For eg: One will be required to consider the variation in interest rates, which hitherto were more or less constant, while planning for his retirement savings. Reduction in agency commission will ensure that products are sold to investors on the basis of their merits. Though these recommendations shall bring year-on-year variability in interest rates, provision of cap and floor of 100 bps shall limit the impact of such variability.

Vishal Shah is a chartered  accountant. He blogs at
http://bachhat.blogspot.com